Open Market Operations Term Paper

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Open Market Operations of the Federal Reserve System

Functions of the Federal Open Market Committee (FOMC)

To many Americans, it may appear that U.S. monetary policy is the work of one man, Alan Greenspan, Chairman, Board of Governors of the Federal Reserve Board ("The Fed"). But that is only because Dr. Greenspan, while certainly an extremely powerful and influential person, is just the most visible of a number of powerful and influential individuals serving on important boards. In the background, out of the limelight, are many other key players, including members of the Federal Open market Committee (FMOC) (which Dr. Greenspan also chairs).

What are the short-term functions of the "open market operations" of the FOMC? Basically, the FOMC sells and purchases U.S. Treasury securities, and securities from federal agencies. This is an important series of tasks, since these transactions are the primary tools for implementing monetary policy established by the Federal Reserve. The primary immediate goal of "open market operations" is to maintain a desired quantity of financial reserves, at a desired price, which is determined as the "federal funds rate." And the "federal funds rate" is the interest rate at which banks and other financial institutions lend balances at the Federal Reserve - to other "depository institutions" around the country through overnight transactions at the Federal Reserve.

What are the overall key functions of the FOMC? The 12-member policy-making committee meets eight times a year (their regularly scheduled sessions) to carefully scrutinize current economic and financial conditions in the country. Then, at those sessions, the FOMC determines the most appropriate plan for ongoing U.S. monetary policy, and also evaluates what risks there may be to the economic picture. If important or crisis-related monetary issues come up between the regularly scheduled meetings, the board may be called to an emergency session, or, be linked on a "conference call" to review and make decisions.

Since the FOMC is the most important policy-making arm of the Federal Reserve, FOMC makes decisions to advance the long-run objectives of "price stability and sustainable economic growth," according to the Federal Reserve's Web site. Basically, big picture of the FOMC's role is one of stimulating the economy, promoting strong economic growth, assuring that employment is strong (near as possible to full employment), setting the cost and availability of credit, and also, to direct System operations in foreign currencies.

How are the FOMC activities coordinated with the Department of Treasury on a daily basis? The FOMC policies directly affect the sale and purchase of U.S. Treasury securities. And since Federal Reserve purchases of U.S. Treasury securities add to reserves, and Federal Reserve sales withdraw from the federal monetary system, there is daily interaction between the U.S. Treasury and FOMC staff.

What is the function of the "Desk" at the Federal Reserve Bank of NY? Each day, professionals at the Domestic Trading Desk must make a decision: whether an open market operation is needed and, if it is, whether the open market operation should be an "outright" or a "temporary operation." What determines how the "Desk" will respond to the market? The "Desk" consults with staff at the Federal Reserve Bank of New York and at the Board of Governors. These staff members then provide the "Desk" with estimates of the average supply of and demand for reserve funds, to maintain the current two-week period of reserves. How does that work? Let's say staff with the Federal Reserve Bank of New York (or Board of Governors staff, numbering 1,700 people) projects a large and persistent imbalance between reserve demand and supply to the Desk. If this imbalance projects to a month or more, the "Desk" may then purchase securities outright, or may also sell securities, to better balance reserves.

II) Reasons for the Fed's historical preference for open market operation as a main tool of monetary policy; 3 primary tools of monetary control

First, the three tools of monetary control (through which the Fed controls the ability of banks to create money) are "open market operations," "discount operations," and changes in the "reserve requirement." Open market operations are the buying and selling of U.S. government (Treasury) securities in the open market; this influences the amount of reserves in the Fed's depository system. Reserve requirements are requirements in the amount of money that depository institutions (including banks) must hold in reserve, to…

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